Must-See: EPI: The Color of Law

Posted on by Brad DeLong

Must-See: EPI: The Color of Law Tickets, Thu, Jun 8, 2017 at 11:00 AM: “On Thursday, June 8th the Economic Policy Institute and the Poverty & Race Research Action Council present Richard Rothstein as he discusses his new book, The Color of Law: A Forgotten History of How Our Government Segregated America… https://www.eventbrite.com/e/the-color-of-law-tickets-34478748866

…Ted Shaw of the University of North Carolina at Chapel Hill School of Law and Rep. Gwen Moore (D-Wis.) will join Rothstein to discuss the history of state-sponsored residential segregation and its enduring effects. In The Color of Law, Rothstein debunks the myth of “de facto” segregation—the idea that U.S. neighborhoods remain segregated primarily because of income differences, private prejudices, or the desires of blacks and whites to live with same-race neighbors. He documents how federal, state, and local governments—with racially explicit intent—segregated American cities from San Francisco to Boston. Rothstein’s book demonstrates that the government’s purposeful creation of American ghettos created the context for conflicts in places like Ferguson, Baltimore, Milwaukee, and Charlotte. And he shows that the unconstitutional state sponsorship of residential segregation not only creates an opportunity, but an obligation for remedial policies to integrate metropolitan areas nationwide. This event is free and open to the public.

Should-Read: Noah Smith: Actually good Silicon Valley critiques?

Posted on by Brad DeLong

Should-Read: Noah Smith: Actually good Silicon Valley critiques?: “Suppose we did want to criticize Silicon Valley and not end up looking foolish… http://noahpinionblog.blogspot.com/2017/05/actually-good-silicon-valley-critiques.html

…Here are some candidates: (1) Silicon Valley culture is still too sexist…. (2) Silicon Valley is late coming out with the Next Big Thing…. (3) Peter Thiel is an evil man…. Thiel’s support of Trump, his habit of making a buck off of government surveillance, and his promotion of nasty political ideas combine to make him the closest thing America has to a comic-book evil mastermind…. I certainly wouldn’t mind if tech industry people got more vocal about disagreeing with Thiel’s values. (4) Silicon Valley is too blase about disruption. Economists are rapidly learning they were wrong about something big—the economy is not as flexible and dynamic as many had assumed…. (5) Tech might be in the middle of a bust…. Notice that this is pretty weak tea…. All in all, Silicon Valley represents one of the least objectionable, most rightfully respected institutions in America today.

Must-Read: Narayana Kocherlakota: The Fed Needs a Better Inflation Target

Posted on by Brad DeLong

Must-Read: Narayana Kocherlakota: The Fed Needs a Better Inflation Target: “A higher goal, with more public support, would benefit the central bank and the economy… https://www.bloomberg.com/view/articles/2017-06-08/republicans-weren-t-smiling-about-comey-or-trump

…Today, a group of economists published a letter urging the U.S. Federal Reserve to consider a monumental change in policy: raising its target for inflation above the current 2 percent. I signed the letter. Here’s why. The inflation target helps define how much stimulus the Fed can deliver when it lowers interest rates to zero (a boundary below which the central bank has been unwilling to go). In a higher-inflation environment, a nominal fed funds rate of zero results in a lower real, net-of-anticipated-inflation rate—the rate that economists typically see as most relevant for consumer and business decisions…. Experience suggests that the Fed could use the added ammunition. During the most recent period of near-zero interest rates, the U.S. unemployment rate remained above 5 percent for nearly seven and a half years (from May 2008 to September 2015). Chair Janet Yellen has suggested that, if another recession takes the Fed to the zero lower bound, the unemployment rate might stay above 5 percent for close to five years. To put it mildly, these aren’t desirable outcomes. The issue is all the more important because periods of zero nominal rates are likely to be more frequent….

The more important part of the letter is its call for “a diverse and representative commission” to re-examine the monetary policy framework—a much more open and transparent approach than the Fed usually takes. When the policy-making Federal Open Market Committee (of which I was a member) chose the 2 percent inflation target in January 2012, its deliberations were completely hidden from the public. As a result, the target has little buy-in from the public and Congress. Canada has demonstrated a better approach. Every five years, its central bank re-examines the monetary policy framework in light of new data and theory, then codifies the framework in an agreement with the government—that is, with the elected representatives of the people. In the most recent review, the Bank of Canada engaged with the public in many ways, including a lengthy description of the process and a guest post by a high-ranking official on a prominent academic blog. The world’s most powerful central bank should be able to do at least as well…

Rethink 2%

Posted on by Brad DeLong
3 Month Treasury Bill Secondary Market Rate FRED St Louis Fed

Rethink 2% http://populardemocracy.org/sites/default/files/Rethink%202%25%20letter.pdf:

Federal Reserve Board of Governors
Constitution Ave NW & 20th Street Northwest
Washington, D.C. 20551

Dear Chair Yellen and the Board of Governors:

The end of this year will mark ten years since the beginning of the Great Recession. This recession and the slow recovery that followed was extraordinarily damaging to the livelihoods and financial security of tens of millions of American households. Accordingly, it should provoke a serious reappraisal of the key parameters governing macroeconomic policy.

One of these key parameters is the rate of inflation targeted by the Federal Reserve. In years past, a 2 percent inflation target seemed to give ample leverage with which the Fed could lower real interest rates. But given the evidence that the equilibrium interest rate had fallen substantially even prior to the financial crisis, and that the Fed’s short-term policy rate remained at zero for seven years without sparking any large acceleration of aggregate demand growth, a reassessment of this target seems warranted. Such a reassessment is particularly appropriate when the lack of evidence that moderately higher inflation would harm Americans’ standard of living is juxtaposed with the tremendous evidence that a tighter labor market would improve Americans’ standards of living.

Some Federal Reserve policymakers have acknowledged these shifting realities and indicated their willingness to reconsider the appropriate target level. For example, San Francisco Federal Reserve President John Williams noted the need for central banks to “adapt policy to changing economic circumstances,” in suggesting a higher inflation target, and Boston Federal Reserve President Eric Rosengren cited the different context in which the inflation target was set in emphasizing the need for debate about the right target.[1] [2]

In May, Vice Chair Stanley Fischer highlighted the Canadian system of reconsidering the inflation target every five years, saying, “I can envisage–say, in the case of inflation targeting–a procedure in which you change the target or you change the other variables that are involved on some regular basis and through some regular participation.”[3]

The comments made by Fischer, Rosengren, and Williams all underscore the ample evidence that the long-term neutral rate of interest may have fallen. Even if a 2 percent inflation target set an appropriate balance a decade ago, it is increasingly clear that the underlying changes in the economy would mean that, whatever the correct rate was
then, it would be higher today. To ensure the future effectiveness of monetary policy in stabilizing the economy after negative shocks–specifically, to avoid the zero lower bound on the funds rate–this fall in the neutral rate may well need to be met with an increase in the long-run inflation target set by the Fed.

More immediately, new, post-crisis economic conditions suggest that a reiteration of the meaning of the Fed’s current target is in order. In its 2016 statement of long-run goals and strategy, the Federal Open Market Committee wrote: “The Committee would be concerned if inflation were running persistently above or below this objective.” Some FOMC participants, however, appear to instead consider 2 percent a hard ceiling that should never be breached, and justify their decision-making on that basis. It is important that the Federal Reserve makes clear–and operates policy based on–its stated goal that it aims to avoid inflation being either below or above its target.

Economies change over time. Recent decades have seen growing evidence that developed economies have harder times generating faster growth in aggregate demand than in decades past. Policymakers must be willing to rigorously assess the costs and benefits of previously-accepted policy parameters in response to economic changes.

One of these key parameters that should be rigorously reassessed is the very low inflation targets that have guided monetary policy in recent decades. We believe that the Fed should appoint a diverse and representative blue ribbon commission with expertise, integrity, and transparency to evaluate and expeditiously recommend a path forward on these questions. We believe such a process will strengthen the Fed as an institution and its conduct of monetary policy, and help ensure wise policymaking for the years and decades to come.

Yours,

Dean Baker
Laurence Ball
Jared Bernstein
Heather Boushey
Josh Bivens
David Blanchflower
J. Bradford DeLong
Tim Duy
Jason Furman
Joseph Gagnon
Marc Jarsulic
Narayana Kocherlakota
Mike Konczal
Michael Madowitz
Lawrence Mishel
Manuel Pastor
Gene Sperling
William Spriggs
Mark Thoma
Joseph Stiglitz
Valerie Wilson
Justin Wolfers

[1] John Williams, “Monetary Policy in a Low R-Star World,” August 15, 2016

[2] Sam Fleming, “Inflation Goal May Be Too Low, says Fed’s Rosengren,” Financial Times, April 21, 2015

[3] Greg Robb, “Fed’s Williams Backs Changing Central Bank’s Strategy to Price-Level Targeting,” Market Watch, May 5, 2017

Weekend reading: the “real-live experiment” edition

Posted on by Kavya Vaghul

This is a weekly post we publish on Fridays with links to articles that touch on economic inequality and growth. The first section is a round-up of what Equitable Growth published this week and the second is the work we’re highlighting from elsewhere. We won’t be the first to share these articles, but we hope by taking a look back at the whole week, we can put them in context.

Equitable Growth round-up

Central bankers often overlook income and wealth inequality when it comes to establishing monetary policy. But as Nick Bunker explains, new research teases out this interaction, finding that monetary policy can help increase consumption through redistributing income across households.

The latest data from the Job Openings and Labor Turnover Survery—more commonly known as JOLTS—on hiring, firing, and other labor market flows came out this week. Nick Bunker unpacks the numbers through a series of charts.

Is inequality affecting global macroeconomic and financial stability? Salvatore Morelli explores the question, asserting that growing inequality is hurting economies and argues that a more equal distribution of resources could be a benefit.

Links from around the web

This week, Kansas’s state legislature voted to increase taxes, overriding the $1.2 billion in tax cuts ordered by Governor Sam Brownback. Gov. Brownback’s “’real-live experiment’ in conservative economic policy,” as Max Ehrenfreund puts it, failed to boost the economy, and even after the tax increase, poor Kansans will pay a greater percent of their income than the rich. [the washington post]

Speaking of taxes, in general, the poorest Americans pay a surprisingly high percent of their income in taxes. Vanessa Williamson elaborates on just how much those at the bottom pay and how it contradicts common perceptions about taxpayers in the U.S. [pbs]

Corporate governance reform has seen mixed results, argues John Matsusaka. Reforms that help grow a firm’s exposure to competition are important, but at the same time reforms that give special interest shareholders more strength have been detrimental. [pro-market]

Carola Binder takes a closer look at labor market trends that help explain why the United States continues to experience low core inflation at a time when unemployment is low. She posits that a paper by Christopher Erceg and Andrew Levin offers a compelling rationale. [quantitative ease]

Tech companies have been increasingly dipping their toes into the U.S. public education system. But these philanthropic efforts may not be improving educational achievement. In fact, Natasha Singer finds that they are swaying school policies to benefit the tech industry. [new york times]

Friday figure

From “JOLTS Day Graphs: April 2017 Report Edition”

Must-Read: Tim Carmody (2010): Stock and Flow

Posted on by Brad DeLong

Must-Read: Tim Carmody (2010): Stock and Flow: “Stock and flow is the master metaphor for media today… http://snarkmarket.com/2010/4890

…Here’s what I mean:

  • Flow is the feed. It’s the posts and the tweets. It’s the stream of daily and sub-daily updates that reminds people you exist.
  • Stock is the durable stuff. It’s the content you produce that’s as interesting in two months (or two years) as it is today. It’s what people discover via search. It’s what spreads slowly but surely, building fans over time….

Flow is ascendant… but we neglect stock at our own peril… both in terms of the health of an audience and, like, the health of a soul. Flow is a treadmill…. One day you’ll get off and look around and go: oh man. I’ve got nothing here…. I’m not saying you should ignore flow! No: this is no time to hole up and work in isolation, emerging after long months or years with your perfectly-polished opus. Everybody will go: huh? Who are you? And even if they don’t—even if your exquisitely-carved marble statue of Boba Fett is the talk of the tumblrs for two whole days—if you don’t have flow to plug your new fans into….

You can tell that I want you to stop and think about stock here. I feel like we all got really good at flow, really fast. But flow is ephemeral. Stock sticks around. Stock is capital. Stock is protein. And the real magic trick in 2010 is to put them both together…

Why the Fed Should Rethink Its 2%/Year No-Lookback Inflation Target

Posted on by Brad DeLong

Conference call today at 9:00 PDT/noon EDT on why the Federal Reserve would be very smart to abandon its 2%/year no-lookback inflation target for a less destructive policy framework. The call is to be moderated Shawn Sebastian. Then Josh Bivens will summarize his short whitepaper: “Is 2% Too Low? Rethinking the Fed’s Arbitrary Inflation Target to Avoid Another Great Recession” http://www.epi.org/publication/is-2-percent-too-low/. Jason Furman will talk about the evidence for the fall in the equilibrium Wicksellian neutral rate of interest and the implications of that for optimal monetary policy. I come next. Joe Stiglitz wraps up. And then questions from reporters.

My task is to set out what the arguments on the other side are—and why we do not find them convincing:

I hear four arguments for not changing the 2%/year inflation target, even though pursuing that target found us in a situation where monetary policy was greatly hobbled in its ability to manage the economy for a solid decade. And, as best as I can evaluate them, all four of these arguments seem to me to be wrong. They are:

  1. The Federal Reserve, even at the zero lower bound, has powerful tools sufficient to carry out its stabilization policy tasks (Cf.: Mankiw and Weinzierl (2011) https://scholar.harvard.edu/files/mankiw/files/exploration_of_optimal.pdf), so moving away from 2%/year as a target is not necessary. The response is: This leaves begging the questions of why, then, employment has been so low over the past decade, and why production is still so low relative to our circa-2007 expectations.

  2. The problem is not the 2%/year target but rather pressure on the Federal Reserve: pressure from substantial numbers of economists and politicians practicing bad economics and motivated partisan reasoning. (As an example, somebody sent me a video clip this week of the very smart Marvin Goodfriend half a decade ago, arguing that faster recovery required the Fed to hit the economy on the head with a brick to make people more confident in its willingness to fight inflation http://www.bradford-delong.com/2017/06/on-the-negative-information-revealed-by-marvin-goodfriends-i-dont-teach-is-lm.html.) The response is: This ignores the Fed’s long institutional history of being willing to ignore outside pressure as it performs its standard monetary policy task of judging what appropriate interest rates are. Pressure only mattered when we got into “non-standard” monetary policies, which we needed to do only because the low inflation target had caused us to hit the zero lower bound.

  3. At 2%/year, inflation is non-salient: nobody worries about it. A higher inflation rate would bring shifting expectations of inflation back into the mix, distract people and firms from their proper task of calculating real costs and benefits to worry about monetary policy, and make monetary policy management more complicated. The response is: But right now people and firms are “distracted” by the high likelihood of depressions that last longer than five years. That is a much bigger distraction than worrying about whether inflation will be 4%/year of 5%/year. And right now the zero lower bound makes monetary policy management much more complicated than it was back in the 1990s when the impact of Fed policy on inflation expectations was in the mix.

  4. The Federal Reserve needs to maintain its credibility, and if it were to even once change the target inflation rate, its commitment to any target inflation rate would have no credibility. The response is: But the credibility you want to have is credibility that you will follow appropriate policies to successfully stabilize the economy—not credibility that you will mindlessly pursue a destructive policy because you think it somehow wrong to acknowledge that the considerations that led you to adopt it in the first place were wrong or have changed. As my friend Daniel Davies puts it in his One-Minute MBA Course: “Is a credible reputation as an idiot a kind of credible reputation one really wants to have?” http://crookedtimber.org/2006/11/29/reputations-are-made-of/

Over to you, Joe…

“Populism” or “Neo-Fascism”?: Rectification of Names Blogging

Posted on by Brad DeLong

The highlight of last week’s JEF-APARC Conference at Stanford https://www.jef.or.jp for me was getting to sit next to Frank Fukuyama https://fukuyama.stanford.edu, whom I had never met before.

Frank is a former Deputy Director of Policy planning at the State Department, author of the extremely good books on political order The Origins of Political Order: From Prehuman Times to the French Revolution http://amzn.to/2sEt4AI and Political Order and Political Decay: From the Industrial Revolution to the Globalization of Democracy http://amzn.to/2sU0WZP, and a very sharp guy.

He has also been smart and lucky enough to have a truly singular achievement in his career. Prince Otto von Bismarck said that the highest excellence of a statesman “is to hear God’s footsteps marching through history, and to try and catch on to His coattails as He marches past…” For an intellectual, there is an equivalent and analogous excellence: to recognize what the powerful historical forces of the next generation will be, to grab onto their coattails, and so write an article that provides an incisive and valuable interpretive framework that makes sense not of the generation past so much as of the generation to come.

John Maynard Keynes, I think, accomplished this in 1919 with his Economic Consequences of the Peace http://amzn.to/2sTZdn7. George Orwell’s Road http://amzn.to/2sgiUZO and Homage http://amzn.to/2s4RK8h, I think, accomplished this in the mid-1930s. George Kennan’s “Long Telegram”—published as “Sources of Soviet Conduct” http://nsarchive.gwu.edu/coldwar/documents/episode-1/kennan.htm certainly ccomplished this in 1946. Perhaps Karl Polanyi accomplished this with his brilliant but annoyingly flawed 1944 The Great Transformation http://amzn.to/2rMsPDq. I really cannot think of anybody else.

And, of course, Frank Fukuyama accomplished this with his 1989 article: “The End of History?” http://www.wesjones.com/eoh.htm. (If you doubt that, go read the brilliant Ralf Dahrendorf’s brutal commentary on Fukuyama in his Reflections on the Revolution in Europe http://amzn.to/2sTXfTE: Fukuyama definitely struck a powerful nerve, and Dahrendorf’s animus springs not from Fukuyama’s shortcomings but rather from his insights.)

This is, for an intellectual, something that requires extreme luck and extreme intelligence. It is a righteously awesome accomplishment. And Frank Fukuyama did it.

I spent my time sitting next to Frank attempting to irritate him with respect to what he and many others call “populism”, for I do not like to hear it called “populism”.

The original American populists were reality-based small farmers and others, who accurately saw railroad monopolies, agricultural price deflation, and high interest rates as crippling their ability to lead the good life. They sought policies—sensible, rational policies in the main—to neutralize these three historical forces. They were not Volkisch nativists distracted from a politics that would have made their lives better by the shiny gewgaws of ethnic hatred and nativism The rise of those forces—of Jim Crowe and the renewed and anti-Catholic Ku Klux Klan and so forth—were not the expression of but rather the breaking of populism in America.

The post-WWII Latin American populists were also people who correctly thought that their ability to lead the good life was being sharply hindered by a system rigged against him. The problem with post-WWII Latin American populism was that the policies that it was offered by its political leaders were—while materially beneficial for the base in the short run—economic disasters in the long: price controls, fiscal expansion ending in unsustainable that burdens, and high tariffs were especially poisonous and false remedies because it could look, for the first five or so years, before they crash came, like they were working.

But what is going on today, whatever it is properly called, is not offering sensible policies people oppressed by monopolies and by a creditor friendly and unemployment causing monetary system. It is not even offering them policy cures that are apparently efficacious in the short run even though disastrous in the long. What Lech and Jarosław Kaczyński, Viktor Orban, Marine Le Pen, Teresa May, and Donald Trump have to offer is (a) redistribution of wealth to family and friends, (b) a further upward leap in income and wealth inequality via cutbacks in social insurance programs coupled with further erosion of progressive taxation, and, most of all, (c) the permission to hate people who look different from you—plus permission to hate rootless cosmopolites who are, somehow, against all principles of natural justice, both doing better than you and offering you insufficient respect.

That is neither the post-WWII Latin American nor the pre-WWI North American form of “populism”. I do not think we are well served by naming it such.

What should we name it instead?

There is an obvious candidate, after all.

When Fukuyama wrote his “The End of History?”—note the question mark at the end—his principal aims were twofold:

  1. To advance a Hegelian, or a Kojeveian reinterpretation of Hegelianism, as pointing out that history was ultimately driven by the evolution of ideas of what a good society would be like and consequent attempts to realize them: through Republican, Imperial, Christian, feudal, Renaissance, Enlightenment, rule of law, democratic, socialist, and fascist formulations, the world’s conceptions of a good society unfold and develop.

  2. To point out that it now appears—or appeared in 1989—that this Hegelian process of conceptual development had come to an end with the liberal democratic capitalist state and economy: private property rights and market exchange guaranteed by a government controlled by one person-one vote now had no serious challengers, and so this process of historical development—what Fukuyama called History-with-a-capital-H—had come to an end.

Most of Fukuyama’s “The End of History” is concerned with the crashing and burning of the idea that the Marxist diagnosis that private property was an inescapably poisoned institution implemented by a Leninist cadre that then set up a Stalinist command economy offered a possible way forward toward a good and free society of associated producers—an alternative to the system that was the reinforcing institutional triad of liberalism, democracy, and capitalism. But there was another challenger for much of the twentieth century: fascism. In Fukuyama’s words:

[Fascism] saw the political weakness, materialism, anomie, and lack of community of the West as fundamental contradictions in liberal societies that could only be resolved by a strong state that forged a new ‘people’ on the basis of national exclusiveness… [an] organized ultra nationalist movement with universalistic pretensions… with regard to the movement’s belief in its right to rule other people…

And, in Fukuyama’s judgment, fascism:

was destroyed as a living ideology by World War II. This was a defeat, of course, on a very material level, but it amounted to a defeat of the idea as well…

But is the current International—that of Kaczyński, Orban, Le Pen, May, and Trump—usefully conceptualized as “fascist”. Perhaps we should say “neo-fascist”, to be politically correct. It certainly believes in the right of its Volkisch core to rule other people within the boundaries of the nation state—or to expel them. It certainly believes that international politics is overwhelmingly a zero-sum contest with winners and losers. It has negative tolerance for rootless cosmopolites and others who see an international community of win-win interactions. A strong leader and a strong state who will tell people what to do? Check. An ethnic nation of blood-and-soil rather than an elected nation of those who choose to live within its boundaries and pledge their allegiance to it? Check. Denunciations of lack of community, anomie, and weakness? Check. The only things missing are (a) denunciations of materialism, and (b) commitments to imperial expansion.

Fukuyama made it clear last week that he greatly prefers “populism” to “neo-fascism” as a term describing what is going on. A fascist movement, he wrote back in 1989, has to be expansionist rather than simply seeking the advantage of the Volkisch national community. There have to be:

universalistic pretensions… with regard to the movement’s belief in its right to rule other people. Hence Imperial Japan would qualify as fascist while former strongman Stoessner’s Paraguay or Pinochet’s Chile would not…

And this test is one that Kaczyński, Orban, Le Pen, May, and Trump’s International fails.

But is Fukuyama right? I am unconvinced. I suspect that calling the movement “populist”—whether with reference either to the pre-WWI United States or post-WWII Latin America—misleads it. I suspect that conceptualizing it as “neo-fascist” might well lead to insights…

Must- and Should-Reads: June 7, 2017

Posted on by Brad DeLong

Interesting Reads:

Is growing inequality hurting our economies?

Posted on by Ed Paisley

The debate over the legitimacy of powerful elites seizing a bigger share of the national income and wealth pie year after year has been gaining prominence in the public conversation. Mark Zuckerberg himself—one of the wealthiest men in the world—remarked that “today, we have a level of wealth inequality that hurts everyone” during his recent speech at Harvard University after receiving an honorary degree.

Researchers and scholars have also begun to clearly break the recurrent classic dichotomy between equity and efficiency pervading conventional economic theory, which led to the neglect of distributional issues for many decades. More broadly, the idea that the understanding of economic inequality “assists our understanding of various fields of economics”1 is now put at the forefront. A clear example of this paradigm change is the realization that transmission mechanisms of monetary policy may be substantially affected by distribution considerations.2

The recent 2007–2008 collapse of the global financial system naturally acted as a catalyst for growing concerns around the increasing dispersion of economic resources within most advanced economies. Subsequently, the landmark book by Thomas Piketty, Capital in the Twenty-First Century, underlined very clearly the risk of the rising importance of inherited intergenerational advantages in transforming our societies into patrimonial capitalistic economies dominated by wealthy dynasties. Yet the main argument of the book rests on how wealth inequality evolution over time may be affected by macroeconomic circumstances—namely by the difference between the average return to capital and the rate of growth of the economy.3 The reverse direction of inquiry—how macroeconomic performance may be affected by the extent of inequality—rests instead outside the scope of Piketty’s analysis and modeling.

A review on the inequality-macroeconomics nexus

The idea that inequality may be one of the factors affecting macroeconomic performance and financial stability is the object of inquiry of a chapter that I wrote in the newly published book After Piketty: The Agenda for Economics and Inequality.4

In fact, the investigation of the (fairly complex) relationship between inequality and economic growth has been featured prominently in the empirical literature on inequality, with disparate findings and hypotheses pointing in different directions. Theoretically speaking, this should be expected, as, on the one hand, income and wealth dispersion stemming from differences in effort, productivity, and risk attitude are a fundamental prerequisite for investment and innovation incentives. On the other hand, high levels of economic inequality can, through a variety of channels—consumption, investment in physical and human capital, or rent-seeking behavior—negatively affect economic growth.

As more and more reliable data became available to researchers, the subject has fallen again under active empirical scrutiny. In fact, a growing body of empirical evidence is now suggesting that the idea that a fairer distribution of economic resources damages economic growth is clearly not supported by the available data.5

Why would economic growth benefit from a fairer distribution of resources?

Economic theory provides different anchors as to why the so-called equity-efficiency trade-off may fall apart.

First, if most of the dispersion of economic outcomes of individuals results from inequality of opportunities—in other words, from circumstances outside their own control such as family background, race, and gender—the potential and aspirations of individuals can be constrained, the allocation of resources may be distorted as economic opportunities are not necessarily given to the most talented but to individuals with predetermined circumstances, and economic growth may in turn be weakened.

Second, high levels of income and wealth inequality, in combination with imperfection of both capital and insurance markets, may be detrimental to the level of economic activity as only those who inherit sufficiently high wealth may be able to pay the fixed cost of entrepreneurial activity or education, becoming more productive and better-paid skilled workers.6 This is detrimental, as education may be precluded to people with the highest possible marginal gain from education and if we believe that entrepreneurial skills are randomly distributed and not themselves acquired dynastically in house/firm.

Third, investments in productive capital and risky activities themselves can also be discouraged by highly unequal distribution of resources as a result of increasing rent-seeking behavior and other expropriation actions, which can be undertaken by the government or relatively poor or rich people alike (depending on the specific political economy model we have in mind). In particular, the expropriation may be perpetrated by wealthy elites even in our modern advanced economies via “subverting legal, political and regulatory institutions to work in their favour,” further increasing their level of wealth.7

But does wealth inequality really promote rent-seeking behavior? A recent work by Bonica and Rosenthal documented the U.S. campaign contributions of the Forbes 400 wealthiest individuals between 1982 and 2012. Their figures imply an average individual donation of $10,000 for each $1 million increase in wealth—presumably a relatively easy achievement for a billionaire.8 The high degree of political activism of wealthy Americans also features in research by Page, Bartels, and Seawright showing that almost half of very wealthy respondents of a survey conducted in the metropolitan area of Chicago made at least one contact with a congressional office within the previous six months of the interview. Moreover, about half of the contacts that could be coded “acknowledged a focus on fairly narrow economic self-interest.”9 Unsurprisingly, the latter does not always coincide with the overall general interest. In line with this framework, a recent work by Bagchi and Svejnar documented a negative relationship between wealth inequality and economic growth in those countries where the extent of wealth inequality is mainly ascribed to “political connections”.10

Going beyond economic growth

Economic growth is certainly one important aspect of macroeconomic performance. However, other features of the growth process and macroeconomic performance may be relevant too. For instance, the volatility of the growth path, the sustainability of economic growth, the resilience of the economy to a shock, the duration of economic recessions, and the incidence of financial imbalance and instability can all be very important characteristics of macroeconomic performance that are worth exploring. These issues are treated in turn below.

Is inequality leading to volatile aggregate performance and to short-lived growth?

Research by the IMF certainly does not reject these hypotheses. On the one hand, countries with higher income inequality appear not to be able to sustain GDP growth for long once it started.11 On the other hand, 70 percent of changes in U.S. consumption during the decade from 2003 to 2013 was found to be associated to the behavior of individuals in the top decile of the income distribution.12 Indeed, these numbers suggest, as remarked by Robert Frank, that “America’s dependence on the rich plus great volatility among the rich equals a more volatile America.”13 The influential work by Mian and Sufi suggested instead that poorer U.S. households (highly leveraged and with high marginal propensity to consume) took the largest hit from the drop in post-2007 U.S. house prices and therefore were responsible for the large drop in aggregate consumption and subsequent employment losses.14 At a first glance, the two ideas may appear at odds with each other but they can perhaps be reconciled if seen as different sides of the same inequality coin.

Are recessions in more unequal countries deeper and do they last longer?

Support for the idea that income inequality can retard full economic recovery following recessions is found in studies for the case of the United States, both at the aggregate level and at a state level.15 In addition, an earlier cross-country study by Rodrik highlighted how countries with greater social cleavages and weaker institutions experienced the sharpest drops in GDP growth from 1975 to the late 1980s (a highly turbulent period from the macroeconomic point of view)—the idea being that policies implemented in response to an external shock usually carry substantial distributional implications, while the latent social conflict and high social division (“along the lines of wealth, ethnic identity, geographical region or other divisions”) that permeates the economy may delay their implementation and lead to “macroeconomic mismanagement.” It is reasonable to assume that each independent group would seek to bargain a lower burden of a negative shock and the share of resources devoted to counterproductive rent-seeking activities increases.16 As a result, the magnitude of the collapse of growth due to external shocks can be higher, and the resilience of the economy to external shocks can be damaged.

Is inequality leading to financial instability or the accumulation of financial imbalances?

A number of theoretical considerations have been put forward to suggest that the degree of inequality can have a direct effect on aggregate savings and consumption and on both demand for and a supply of credit. Relative income and spending comparisons may, for instance, have important influence on what people spend their money on, how much they save, and even how much debt they accumulate.

Empirical findings are so far controversial: Research based on aggregate data and cross-country analysis emphasize positive correlations between inequality, household overconsumption, and indebtedness, whereas the evidence based on microdata appears less consistent and supportive of this hypothesis. Similarly, little evidence was found in support of the idea that rising inequality may increase the probability of a financial crises to occur.17 Yet further investigation of the alleged relationship between inequality and private debt becomes particularly relevant, as the latest crisis was largely the result of the burst of a debt-financed housing and consumption bubble that involved the private sector of the economy.

Growing inequality does not benefit the macroeconomy

After surveying a growing body of new and old evidence on inequality and the macroeconomy, one would easily conclude that increasing income and wealth inequality appear to be sanding the wheels of economic growth, making the ride bumpier, with short ups and deep downs, and potentially increasing the risk of a fatal crash. This may generate an instrumental justification for effective coordinated actions by governments to reduce income and wealth inequality that goes beyond classic concerns about distributional equity and fairness.

At the same time, as I recalled in the chapter from which this article draws on, “no relationships have been robustly demonstrated without qualification.” Furthermore, because establishing a causal relationship even when the empirical association is confirmed is an extremely tricky business, it is imperative to conduct fresh empirical research, also outside the United States, to corroborate some of the empirical findings discussed above, test new hypotheses, and enrich our scientific knowledge to better inform policies. Most importantly, the understanding of the determinants of economic inequality is fundamental to substantiate, case by case, the inevitable contingent nature of the relationship between aggregate performances and inequality. This would caution everyone from the adoption of a new generic consensus on the detrimental effects of inequality on economic stability that “is as likely to mislead as the old one was.”18

If anything, we can now confidently stop justifying increasing inequalities in income and wealth on mere economic grounds.

Reducing inequality, the constraints on substantial freedom and opportunities of individuals, will not frustrate, but possibly will enhance the path of economic prosperity and stability; it is a gain that every democratic society must strive for.

Salvatore Morelli is a visiting scholar at the Institute for New Economic Thinking at the Oxford Martin School, University of Oxford, and associate member of Nuffield College at Oxford as well as a research associate at the Center for the Study of Economics and Finance (CSEF).